My Favorite Stocks to Watch in the Expanding Coffee Market

I love the smell of coffee brewing in the morning—and in the afternoon and evening. As you can tell, I do enjoy my coffee—but I also like watching some of the market’s top coffee stocks.

At the top of my watch list in the coffee sector is Starbucks Corporation (NASDAQ/SBUX), just because of its strong brand recognition not only in the United States but worldwide. Whether it’s in Asia, Europe, or Latin America, you can always find that familiar green Starbucks logo.

However, when I have a craving for a baked treat (though I seldom do), I do like the “Boston Kreme” donut and “Cheddar Cheese Bagel Twist” at Dunkin’ Donuts, operated by Dunkin Brands Group, Inc. (NASDAQ/DNKN), which also owns Baskin-Robbins. Dunkin is known more for its donuts than its coffee; nevertheless, it is a coffee shop that many customers will venture out to for a sweet treat.

Chart courtesy of www.StockCharts.com

Dunkin is still primarily an American brand, but the company is considering returning to the United Kingdom. The company is looking at opening 50 outlets in the greater London area within five years, but that number could run as high as 150 outlets in the United Kingdom. (Source: Rocco, M., “Dunkin’ Donuts Plans Return to U.K.,” Fox Business Network web site, September 12, 2013.) The company also has plans to move into Moscow.

While the expansion plans are encouraging, I really doubt the Dunkin brand can become the global icon that Starbucks has become. In China, for instance, Starbucks is rapidly growing.

An alternative investment opportunity to Dunkin—and a company that the people at Dunkin should be keeping an eye on—is Canada-based Tim Hortons Inc. (NYSE/THI). The company’s product is similar to Dunkin’s, and it is rapidly growing in the United States. As of June 30, 2013, there were 4,304 Tim Hortons outlets in the network, including 807 in the U.S.

Chart courtesy of www.StockCharts.com

In my view, Tim Hortons is more of a threat to Dunkin than Starbucks, especially in the U.S. market, which is growing in importance to Tim Hortons.

The valuation of Tim Hortons is also more attractive, trading at 17.47X its 2014 earnings-per-share (EPS) and a price/earnings-to-growth (PEG) of 1.63; Dunkin is trading at 24.38X its 2014 EPS and a PEG of 1.75.

Dunkin is more of a play on the U.S. coffee market, with its 10,600 outlets, which makes it the second-largest coffee chain in the country after Starbucks.

At this point, from a valuation perspective, I would look more seriously at Tim Hortons than Dunkin.